I will inherit half of three annuities held for 15+ years by my mother. The total amount will be split by my sister and I.
I thought all financial assets were inherited on a stepped-up basis. But someone said if we take a lump sum distribution on the annuities the gains on them will be a taxable event.
Is this right? Why are the gains on stock not taxed upon inheritance, but the gains on annuities taxed? Seems like this is a disadvantage of annuities.
Annuities are designed to provide income. People buy them because they want guaranteed income they can depend on. They’re a different animal from stocks/mutual funds where you buy with the expectation they’ll increase in value, but they don’t always. Annual stock dividends and capital gains fluxuate and don’t provide predictable income. I think that’s why they’re taxed differently.
You will probably pay ordinary income taxes on the inherited annuity, perhaps minus your mom’s purchase price, although I’m not sure since my knowledge on annuities is limited.
There are a lot of misconceptions about inheriting.
Hopefully Clyde will come along and give you more details.
When you inherit an annuity, you have inherited a future stream of payments that has not yet been taxed and the taxability is determined by funding. If the annuity was initially funded with tax deferred dollars, like an IRA, one is taxed whenever those dollars are paid out and all distributions are taxable because the taxes were initially deferred. If the annuity was funded with after tax dollars, then that part of the annuity payout that represents growth will be taxed when paid and that part that represents return of the initial investment will not be taxed. The annuity provider should have the formula based on IRS regs. The tax will be based on whatever amount is considered taxable of the proceeds.
There is no stepped up basis for inherited annuities or streams of payments like an IRA. I think that stepped up basis only applies to assets that would produce a capital gain if sold. Just remember that tax laws are written so that all income is taxable on receipt unless the law specifies an exclusion or exemption.
These were variable annuities invested in stock and bond portfolios. I see now that a Roth IRA would have been a better investment. And I found out if the annuity is liquidated over several years, the gains and interest come out first and are fully taxable.